Epocalypse Coming: Fed Reserves Right to Raise Interest at Worst Time
October came and went without economic apocalypse. In fact, a stock market that plunged in August experienced better than full recovery in October — more than just a bounce. Nevertheless, some think (as do I) that the crash has begun, and that it will unfold as a cascade of worsening catastrophes. So, get ready for the epocalypse. (“Apocalypse now: has the next giant financial crash already begun?“)
A mountain of debt is banked up against the entire global economy
A formidable super volcano of global debt has grown since the Great Recession began, which means a small rise in interest rates now (as is looking more likely from the Fed) is all it would take to add enough pressure to cause the volcano to erupt. Nearly $60 trillion of additional debt was heaped up all over the world in our effort to extricate ourselves from the Great Recession. Smaller nations like Brazil and Greece and Puerto Rico are already crumbling under the weight of their portion of this mountain.
This crushing of small economies will continue for years to come because it would take many years to pay down debt that has piled up faster than the world has ever seen debt pile up … if we ever can pay it down. Simple reasoning: if the debt has taken seven years to pile up to a height that was unbelievable a decade ago, it will certainly take thirty years to get out from under it simply because there is no limit to how fast nations can pile up debt other than the limits they choose to accept but there is an infinite number of limiting factors to how quickly they are able pay it back down.
When the price of money is the lowest it has ever been, businesses buy a lot of nearly free money, just as do nations; but what happens when many of those same businesses go to refinance bonds in three years, and the price of borrowed money has gone up? Many corporations that issued bonds to finance their buy-back of stocks are seeing revenue now decline to where they will have less to pay off bonds when a time of higher interest arrives.
The only way the Federal Reserve’s stimulus program could ever pay off the worst overhang of debt this nation has ever known would have been if the formation of all that debt created equally rapid, sustainable economic growth as it was intended to. In order for revenue to dig away the mountain faster than the volcano is rising due to interest economic growth would have to be phenomenal. But it wasn’t and clearly will not be for a long time to come because…
Super debt meets recession
Even though all that mountain-building was intended to stimulate the economy, growth in revenue never gained momentum and is now stalling out in the US and in China and almost all other countries, except for those where there is no growth at all, but only recession.
And that is probably inevitable. Demographics in European and North American economies are flowing directly against any hope of building economic momentum. The baby-boom generation that drove a consumer economy with the purchase of millions of new cars and new and bigger homes, food, toys, consumption of resources, has just begun to enter retirement. When people enter retirement, they become dependent on pensions and savings, rather than creating new wealth to store up pensions. When they become dependent on pensions, they reduce spending. That tide against the growth of consumption will pick up speed in the next few years as the peak of baby boomers enter retirement.
The golden days of the global economy are over because we are now entering the golden years of the baby boomers. Not only will retirees no longer contribute to the expansion of GDP via their own productivity, they also will also start to downsize their homes and buy fewer expensive toys than they did in the peak of their career.
This would be the normal transition, but it is going to be made worse by the fact that those pensions have performed poorly under the Federal Reserve’s zero-interest policies and because they lost a lot of wealth during the worst of the Great Recession. This wave of retirees will almost all discover they have smaller incomes to live on for the rest of their lives than they anticipated.
We are now entering such a massive demographic shift in the world that it has to negatively impact economic growth. True, the boomers will shift to buying more prosthetics, more health care, more medicines; but there will be fewer and fewer of them, and they will be living on much tighter incomes, so this has to cinch the global economic belt.
Nurial Roubini, the celebrated economist of New York University, points out, as I have many times here, that few of the structural economic reforms that needed to happen have happened. Politicians, unable to find any agreement on fiscal policy, relied entirely on central banks to solve economic problems that were structural in cause. The result has been a mere temporary lift, due to unprecedented central-bank stimulus, which might have eased our pain during the working out of those problems; but none of the problems were worked out, and the banks have now exhausted the effectiveness of their monetary anesthesia.
Don’t be fooled by the US stock market’s rally
The October rally is a bear rally, not a bull rally. I say that because the stocks that have soared are only the mega-stocks that were already the highest performers of the year. That handful of great performers has left the majority of other stocks down in the dusty pit to which they slid in August. It is far from a full-market rally. Because the other stocks, which are going down or holding flat, are not trading much volume, their prices have little effect. The mega stocks, on the other hand, are trading in good volume because that is where the last of desperate money is rushing.
As Marc Faber notes, indexes are built out of a small number of top stocks so that 1% of the stocks in an index can drive up the index while others just sit there. Says Faber, “Like yesterday: out of more than three-thousand shares that are being traded, only less than a hundred made a twelve-months new high. If you take the whole world, it’s very few shares making new highs, and the majority are down already twenty, thirty or forty percent.”
When a rally is as narrow as this one has been, it easily crashes.
In spite of the rocket rise in the S&P 500 during October, third-quarter profits for the three-quarters of the nation’s corporations that have reported their earnings are down by an average of 3.1%. That’s the largest quarterly drop in earnings since 2009.
The bear rally exists because the Fed’s free money is still flowing into certain popular stocks. In fact, I would not be surprised if the borrowing of money to invest in the surest stocks has even picked up because people believe the end of free money is near. So, this may be a last hurrah. The money the Fed pumps out has to have somewhere to go, even though business is solidly down. The free money is simply funneling into the top cream of the stock market while other stocks are idling or sinking.
This is the first time since the end of the Great Recession was called that earnings growth has turned so negative. What kind of a rally is that, regardless of how impressively it graphs out?
It’s no shock to anyone that energy shares have dropped 54% in earnings per share just in the present quarter. The rally looks steep, but it’s a high splash, not an ocean swell. The industrial environment — not just the energy sector — is, in fact, in a recession. Industrial output declined in both August and September.
The nation’s economy overall is not much better, with GDP growth having slumped last quarter to an annualized 1.5%.
So, the support for the stock market rally is narrow, at best, and is funded almost entirely by the Fed’s free money, which is likely ending this quarter. With such poor results in earnings, the rise of the stock market will turn south as soon as the Fed ends it zero-interest policy (and, in fact, quite possibly on its own before then).
Says Walter Todd, chief investment officer of Greenwood Capital,
We’ve been lamenting that it’s very hard to have conviction right now, either way,…. While the market has rallied very strongly and it’s pleasant to be involved in that, it’s so unclear what’s going to win out. Is the drag from the industrial economy going to take down the other part of the economy? …If anything, it’s become more clear that the industrial side of the economy and anything it touches is in a recession.”
Tell-tale signs that the industrial economy is in recession
In addition to the numerous declines in heavy industry that I have reported in other recent articles, let’s look at the one industry that indicates what is happening in all others — transportation.
- Rail car orders were down 83% in the third quarter. That’s the largest drop in 27 years. Rail car orders have plummeted because rail freight is down, and the drop in the order of new cars indicates railroads do not expect this to turn around anytime soon.
- According to Reuters, “Freight carried by major U.S. railroads fell by 7 percent in the second quarter of 2015 compared with the same period in 2014, confirming that large parts of the industrial economy are in recession.”
- The Shanghai Containerized Freight Index shows that shipping rates by containerized ships have plummeted 27% in one recent week due to lack of demand. That’s on top of previous weeks of decline for a total decline over three weeks of 60%. I believe that is an historic record.
- This is not just because too many ships have been ordered. A third of the containers that ship out of Los Angeles and Long Beach are being shipped empty because US exports are falling behind imports due to the strong dollar (and a rise in the Fed’s interest rate policy will make the dollar even stronger).
- Recently, I reported that some of the largest trucking companies in the United States have stopped ordering new trucks and are actually looking at reducing their fleet size. The trucking industry was booming two months ago to where it couldn’t buy sildenafil citrate 50 mg come close to finding enough drivers, but now it’s having a harder time finding loads. Trucks are sitting idle. Every month this year, load-to-truck ratios were below the ratios in 2014. By September, the ratio was 42% below a year earlier!
Shipping is certainly a thermometer of the economy. If things aren’t moving, it means things aren’t selling, and if things slow down in selling, they will soon slow down in manufacturing (if they have not already). The stacking up of inventory allows a little buffer, but not much.
Hedge fund manager Stanley Druckenmiller says that we are seeing now the end result of the Fed’s low interest:
All you do when you’re doing this [low-interest stimulus] is you’re pulling demand forward to today. This is not some permanent boost you get. You’re borrowing from the future.
In other words, free money in the recent past enticed us to buy everything we thought we might need or want; so there is not much market now or in the near future. That’s why business inventories are high and consumption isn’t growing. Manufacturers are having to layoff employees to keep those inventories from stacking up.
Federal Reserve’s interest rate hike likely at the worst time
It is in this environment that the Fed is finally ready to raise interest rates, and these negative economic factors that I’ve pointed out above are not really the ones that the Fed is looking at. Therefore, they are not likely to give them much thought. The Fed is obsessed with jobs, as jobs are today.
Bill Gross, one of the United State’s most successful bond-fund managers, says that he now sees a Fed rate hike in December of 2015 as being 100% certain. Even Gross’s former rival, Mohamed El-Erian, agrees:
Because of the things the Fed considers as part of its dual mandate to maintain stable prices while ensuring maximum employment, this jobs report is consistent with the central bank hiking rates for the first time in almost 10 years. But since the Fed’s policy-making officials don’t meet for another six weeks, it matters a lot what happens in the interim.
Given what all the talking heads are calling a “stellar jobs report” this week, and given that the Fed already said it didn’t expect jobs to get much better, jobs must surely have arrived this week at the best the Fed thinks they can be. Since keeping inflation below 2% and keeping the job market strong is the Fed’s dual mandate from the US government, they have run out of reasons to keep interest low. All their gauges are now exactly where they want them to be.
There are, as this article points out, many other gauges that are leading indicators for the economy that look bad, but the gauges for unemployment and inflation look as solid as the Fed hopes to find, and those are the gauges they give 90% of their attention to because of their federal mandate. Unemployment finally hit the magic 5.0% this week. The addition of 271,ooo new jobs was almost 100,000 more than anticipated. Hourly earnings, another factor the Fed has been concerned about, finally jumped at an annualized rate of 2.5%. That’s much better than at any other time since the Great Recession began.
“We can check off a number of good-news boxes with this report. It’s hard to find any bad-news boxes to check off,” said Mark Hamrick, senior economic analyst at Bankrate.com…. “There’s a growing sentiment of let’s get it [the Federal Reserve’s rate hike] done already,” Hamrick said. “From the standpoint of a story coming together that could be very consistent with a rate hike, we got a big collection of data in that regard this morning.”(CNBC)
Earlier this week Fed Chairman, Janet Yellen, described the economy as strong and said that a rate hike in December was “a live possibility.” Minutes from the October 27-28 Federal Reserve policy meeting show Yellen thought December was a strong possibility for the first interest-rate hike in nearly a decade. Other members of the Federal Reserve have said the same thing.
How much more “live” is that possibility, then, with this jobs report … so long as reported data don’t deteriorate significantly between now and the Fed’s December meeting?
Unlike permabear Peter Shiff, I have said that I do think the Fed will raise interest rates and that I think it will cause economic collapse because the collapse is already forming under the pressures I’ve described here and in other articles. In fact, the weight pressing down on the economy is so strong that it could collapse before the Fed raises rates. We saw the possibility of that in August when new from China strained the stock market. The economy, of course, is much more than just the stock market; but, as happens to one, so almost always happens to the other.
Numerous economists have shifted, as a result of this one report from giving bout a 30% chance of a Fed rate hike in December to giving a 100% chance of one:
- “The Fed’s hawks will now argue that they have hard evidence in the most widely watched… data that the tightness of the labor market is pushing wage gains higher. Barring a disaster in November, rates are going to rise in December,” Ian Shepherdson of Pantheon Macroeconomics, told AFP.
- “The case for tightening in December — and a lot more in 2016 — looks increasingly strong,” Jim O’Sullivan, chief U.S. economist at High Frequency Economics, told AFP.
- “It’s a solid labor market,” Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York, told Bloomberg. “The report is pretty good across the board. December is now a very high likelihood for the Fed to hike rates.”
- …”This is a fantastic jobs number at this point in the recovery, and we’re also finally seeing strong wage gains,” Tara Sinclair, Chief Economist for job site Indeed, told the AP. “This data tips the scales toward a rate hike in December, but more importantly is a sign that our economy may have more punch than we thought.”
- “That was an astounding number. It’s pretty clear that the Fed would be justified in hiking in December if the economy doesn’t hit another air pocket,” Brian Jacobsen, chief portfolio strategist at Wells Fargo Funds Management in Menomonee Falls, Wisconsin, told Reuters. (Newsmax)
But the economy doesn’t have more punch than they think. It is running into the largest mountain of debt the world has ever seen, which only becomes heavier when interest rates start climbing; and it is hitting that mountain at the same time the huge driving force of consumption called “baby boomers” is finally starting to wind down.
Yet, you can almost hear music in this jubilant comment:
“The reasons for Fed caution and delay are falling to the wayside as this economic expansion is the real deal,” wrote MUFG Union Bank’s Chris Rupkey in a client note. “Liftoff is coming in December. Bet on it. Savers, your long national nightmare is over. Rates on money in the bank are going up.” (Business Insider)
Statements from Fed officials indicating likelihood of interest rates rising in December
If the US economy doesn’t collapse ahead of this rate hike, the hike will certainly be hitting with the worst possible timing; but I doubt the Fed will see that. I’ve said that a few times. Says Atlanta Fed President and CEO Dennis Lockhart at a banking conference in Switzerland ahead of this jobs report:
It’s my assessment that the U.S. economy is likely in an above-potential growth phase, with labor markets continuing to improve, and with an underlying inflationary trend that, if not rapidly moving toward the FOMC’s objective, is at least not moving away from that objective … Most, though not all, labor market slack has been absorbed … Underlying CPI inflation expectations over the next five years is about 2.1 percent, right in line with the FOMC’s objective. Overall, it appears to me that inflation expectations are fairly well anchored … Liftoff will soon be appropriate … we are in the midst of transition from an extraordinary period that called for unconventional tools, to a period where we again utilize rule-like benchmarks.” (Federal Reserve Bank of Atlanta)
Addressing whether the Fed should hike interest rates next month, the dovish Fed official [Chicago Federal Reserve President Charles Evans] acknowledged, “We’ve indicated that conditions look like they could be ripe of an increase.” … While preferring “more delay or a shallower path,” Evans also told CNBC Friday: “I’ve gone in with an open mind to every meeting. So they’ve been live.” (CNBC)
New York FedPresident William Dudley, addressing reporters, said he would “completely agree” with Fed Chair Janet Yellen who had earlier said December is in play for a policy tightening if the economic data points to further improvement in the labor market and to a rebound in inflation. (CNBC)
Another Federal Reserve official pointed to December as an appropriate time to begin raising U.S. interest rates, as Eric Rosengren said on Monday there has been “real improvement” in the economy of late with the October jobs report delivering “very good news.”
The confident speech by Rosengren, the dovish president of the Boston Fed, amplified the drum beat of U.S. central bankers including Fed Chair Janet Yellen preparing the world for the first U.S. policy tightening in nearly a decade. Rosengren, one of the strongest supporters of policy accommodation since the financial crisis, said it was now reasonable to ask whether the current level of near-zero rates was necessary given he expects the economy to continue expanding. (CNBC)
So, even the “dovish” members of the Fed are prepared to raise rates.
Clearly the Fed doesn’t see the problems coming because it focuses so intently on labor statistics, and its members are increasingly ready to raise rates. So, get ready for a Christmas present from the Fed that will swing us from autumn into the long winter of our discontent. The US stock market may well be bouncing along its old ceiling again at that time or even breaking through, and then the trap door will open. The free money driving the market will fall out, and earnings are already bad. With no more hot air for lift in a hostile environment, the market will start its final descent.